Options Trader: Friday Morning Ideas

by: Philip Davis

Did you get all bearish yet? Have you dumped all your stocks? If so, then the traders have done their jobs.

You see, while they were off on vacation, some of you had the nerve to buy their stocks after they "sold in May and went away." They left the S&P at 1,260 on May 15th, and that's where they like it. So, just like my Grandpa when he comes home and finds the heat on, the big boys are turning the market back down.

I like to ascribe evil macro motives to these things because it's more fun, but there is also a simple economic explanation for this action as well. Mr. Big manages a fund who's goal is to beat the S&P. The fund in May forecasts a downtrend and sells off some shares into the summer doldrums (8-out-of-10 summers, yada yada), pocketing the 6% YTD gain. This is sort of a self-fulfilling prophesy, as the selling drops the S&P, so Mr. Big automatically outperforms it (nice gig).

So he goes on vacation thinking when he gets back he will start buying again. But when he gets home, he finds some jerk bought up his market—back to where he started selling it! This is not good. He is now performing flat to the S&P. But since he still has hundreds of billions of dollars in stocks, he does something very easy—sell some more and take the 5% gains off the table. Again we have the self-fulfilling prophesy, and Mr. Big is again outperforming the S&P, and his table at the yacht club is secure for another year!

The net-effect is that you annoying retail buyers have been shaken out of positions like fleas off a dog. The big guys don't care because they are still half or more in the position for the long-haul, and they are going to "buy on the dips."

The question is, where is their comfort level? They need to get back-in if they have sold more than intended, so what is the entry point? Is it Fibonacci point-A of the S&P at 1,290, just about the mid-point between the year's open at 1,250 and the high of 1,325? Or is it point-B, the 200 (and 50) dma at 1,280?

Either way I think we are close enough to these logical turn signals that I think we may be out of this sell-off by October, but that is small comfort for September 8th...

Asia is bouncing off their 200 DMAs without too much conviction. I like Baidu.com Inc. (NASDAQ:BIDU) on a rebound there, but we need to watch the overhead resistance of the 50 DMA at $80. The BOJ did not raise rates, another boost for the dollar. Europe is poking up hopefully, but is unlikely to make a real move until the US markets confirm direction. The Bank of England, which doesn't play ball with the EU, held their rates at 4.75%.

Here's what really annoys me about Europe: Vivendi posted a 53% rise in net, Suez (NYSE:SZE) is up 39%, Carrefour is up 11% (like WMT), Ahold (Stop and Shop) up 70%, InBev up 22%... This is just this week!!! Come on Europe, people are making money—wake up!!!

It will be surprising if the Dow can turn up before hitting 11,200; it has too much top spin now to pull a U-turn. Likewise, the S&P will be more comfortable moving down a bit more from here, perhaps to 1,280, but a turn there will be very bullish. The NYSE may be the first to turn at either 8,200 or 8,100. Today we need to watch the S&P to see if the early bounce has any legs, as the S&P must hold 8,300 for any kind of rally to take place. The Nasdaq is at a nice mid-point between the inverted 50 and 200 DMA and must lead us one way or the other.

Let's also keep an eye on SOX: 440 = Good, 430 = Bad. And TRANQ, which will signal the real rally, by breaking 2,400 or signal a major pullback below 2,300.

To get perspective on our current situation we have to get in our time machine and go way back to August 14th, when we had just gone through a big sell-off and broken below the 200 DMA on the S&P and things looked very bleak. Oil had broken up to $77 2-days earlier and the doomsayers were out in full force that Monday. Only one nutty guy had a positive outlook:

Oil is seeking a bottom and Iran is talking to the EU this weekend (I know, a government that works on weekends, imagine that!), so I'm glad I'm out of my main oil puts. At this point we need to see if $68 provides a solid ceiling, but hopefully we can get a nice potential floor test of $65 next week. $67 was my target-price in the 8/14 article, and I have to think the old me may have been on right on the money, so I'm getting a little cautious here even though the chart looks pretty dire for oil:

If you missed any oil puts and want to get in you should get a chance today as Florence looks like a storm enough to get the oil pumpers moving again, but the chance of this hitting the Gulf is about 10%, which is only 10% less than the chance of this becoming a cat-3 or greater storm. The whole thing may be over by mid-day if the storm begins to drift north, as it is already tracking way high for a gulf storm.

There's also an OPEC meeting next week, so expect idiot "analysts" to make fools of themselves trying to convince you that people are going to voluntarily not sell you a million barrels of oil a day for $65. Perhaps when oil was only $20 you could get people to hold-off, but if I go to your house and offer you $2 for every glass of water you can give me, are you going to stop because your neighbors are worried you might be saturating the market?

Gold will key off the Dollar, but will have a heck of a time trying to reassert itself if we go back on Fed watch. There's always the crazy world leader factor, but I think Bush is taking the weekend off (since absolutely no one wants him to campaign for them!).

We will have to wait and see which way we go. I think it's a little too early for a turn-up, but I won't be surprised if we get a mega rally in the next 5 sessions. I will be surprised (and back to cash) if we get a mega drop, but a slowing downtrend would suit my master plan just fine.

Fear-of-Fed will dominate this week, but the minutes of the meeting clearly indicate that just 2 of 12 regional banks wanted to raise rates. Since other CBs are holding firm, it is very unlikely the Fed will raise again, just more of the Big boys shaking the tree...

Today's Picks:
Buying today is very risky, it's a nice day - go swimming instead, you're missing the whole summer! I'm only watching a few things today.

• You know how much these things bother me - someone needs to tell Caterpillar Inc. (NYSE:CAT) and Volvo (VOLV) that they are in the same industry. Cat has slightly better growth prospects, and we already made our money there, but let's watch both for a sign to reenter CAT Oct $70s for $1.50 or less when VOLV turns back up.

• Continental Airlines Corp. (NYSE:CAL) took a nice bounce off the 200 dma yesterday so I feel good about the Dec $30s for $1.20.

• I can't believe I'm defending an oil company, but Cramer said General Mills Inc. (NYSE:GIS) is better than ExxonMobil Corp. (NYSE:XOM) because they make .60 on a box of cereal and XOM only makes .10 on a gallon of gas. This is a dangerous drift by Cramer into PT Barnum logic, as you really don't have a valid comparison until Americans start buying a billion boxes of cereal every single day. Come on Jim, don't go Hollywood at the expense of good advice!

• Hewlett-Packard Co. (NYSE:HPQ) is so tempting, but this scandal is out of control. I'm hoping it defies all fundamental logic and trades back down to $33-ish where Cramer and I will both be doing a 'mon back.

• Palm Inc. (PALM) and Research In Motion Ltd. (RIMM) both crack me up. PALM has a P/E of 4.5 thanks to the recent sell-off, while RIMM has a P/E of 40 thanks to the recent run-up. I'm not playing either of these, as the lunatics are certainly running this asylum, but it sure is fun to watch!

• I take it back, RIMM is a good play to defend your calls against a market drop. So as a hedge, I like the Oct $75 puts for $2.80.

• Going back to my article on there being a flood of rigs (which, by some great stretch of logic, analysts can't seem to grasp—may lead to a flood of oil), Baker Hughes Inc. (NYSE:BHI) announced their rig count rose 4% last month:

• Lennar Corp. (NYSE:LEN) says that their 16 analysts are a little off base with their $1.81 Q3 estimate. LEN says $1.30 is the number they come up with. Only one of the 16 analysts have a sell on Lennar... Last Q3, LEN turned in a $2.06 number with a strong Q4 outlook and the stock was at $55. With the earnings down 33% and the outlook in the toilet, it will be interesting to see how low they can go. Oct $40 puts are .80.

• I don't understand the business well enough to play it yet, but Foxhollow Technologies Inc. (FOXH) has some really exciting stuff. Unfortunately, that doesn't always make you rich (think Sirius, Tivo), but this is really the technology of future medicine.

• Oops, Broadcom Corp. (BRCM) says they found a few more bad options.